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Invest like Warren Buffett… but not really

This is a post from staff writer Robert Brokamp of The Motley Fool. Robert is a Certified Financial Planner and the adviser for The Motley Fool’s Rule Your Retirement service.

If you want people to read your investing-related post or book, you’ll increase your chances by mentioning Warren Buffett in your title. After all, I just did it — and it might be why you chose to read this. Every financial media company does it, including us at The Motley Fool.

His investing skills while the chairman and CEO of Berkshire Hathaway have made him the fourth-richest man in the world. Most of the articles and books about him attempt to dissect his investing strategies and explain how you can use them to identify your own winning stocks. So it was a bit surprising when Larry Swedroe wrote Think, Act, and Invest Like Warren Buffett. He’s the director of research for the BAM Alliance of independent financial advisers, the author of several books, and a blogger on CBS Marketwatch. He also thinks that picking individual stocks — as opposed to investing in index funds — is a really bad idea.

I’ve chatted several times with Larry over the years, because he’s as smart as they come on the topics of asset allocation and financial planning. Recently, we had a conversation about why he would write a book singing the praises of the world’s most famous stock picker. Of course, that whole “increase sales by including Buffett in your headline” thing probably had something to do with it. But it’s not just a gimmick; Larry has three main arguments for why the index investor should still listen to the Oracle of Omaha, and he uses actual quotes from Buffett to back them up. And it starts with…

1. Warren Buffett recommends index funds

It may not be widely known, but Buffett is actually a fan of index funds. Here’s what he wrote in his 1996 annual letter:

“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expense) delivered by the great majority of investment professionals. Seriously, costs matter.”

Buffett’s a smart fellow, and he knows his history and his statistics; both establish that it’s pretty darn hard (though not impossible) to outperform an index fund over the long term. Obviously, he doesn’t think this applies to him — he still keeps picking individual stocks (or buying companies outright). But he recognizes the great value of the index fund. The same goes for us at The Motley Fool. My colleagues devote a great deal of time and energy to finding great stocks. But we also have a room named after John Bogle, the founder of the Vanguard family of mutual funds and one of the primary progenitors of the index fund. (Next to the entrance to our Bogle room, we have a picture of Mr. Bogle wearing a Motley Fool cap during one of his visits to our office. It’s pretty cool.)

2. Warren Buffett ignores market forecasts

Wade into the waters of the ever-flowing financial media, and you’ll see an endless flotilla of gurus offering their assessments of where the market is headed. Buffett thinks you should pay them no heed:

“We have long felt that the only value of stock forecasters is to make fortune-tellers look good. Even now, Charlie [Munger, vice chairman of Berkshire Hathaway] and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

In case you need some stats to back that up, CXO Advisory Group analyzed the predictions of 68 “experts” from 2005 to 2012. As a group, they were right less than half the time. You would have been better off flipping a coin than listening to these people.

During our most recent discussion, I asked Larry Swedroe why these people still have jobs. He had a few reasons, but one in particular stood out: “I have come to the conclusion, after my long years of experience both as an adviser to some of the largest corporations in the world on managing financial risk and as adviser to individuals and endowments, that there’s an all-too-human need for us to believe that there’s somebody out there who can protect us from bad things.” I think he’s on to something. Unfortunately, market predictions just create — rather than offer protection from — bad things.

3. Warren Buffett doesn’t try to time the market

You won’t see Berkshire Hathaway buying and selling its stocks or businesses too often. Once a company joins the Berkshire family, it’ll likely be in there for quite a while — decades probably. Here’s what Buffett said about it:

“Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.”

My very first post on Get Rich Slowly was about attending the 2009 Berkshire Hathaway annual meeting. It happened in May, just two months after the stock market hit bottom after dropping more than 50 percent. It was a dang scary time.

During that annual meeting — and at just about every annual meeting over the past several years — the topic of Buffett’s and Munger’s successors came up. After all, Buffett is 82 and Munger is 89. They didn’t name names, but they have some people in mind. However, it won’t be someone who tries to move in and out of the stock market. Here’s what they said:

Munger: I don’t think we’d want an investment manager who would want to go to cash based on macro factors. We think it’s impossible.

Buffett: In fact, we’d leave out someone who thought he could do that.

The important three questions

The main argument that Larry makes in his latest books is this: If you agree that Buffett is one of the greatest investors of all time, then take his advice. And the next time you’re inclined to act according to some expert’s forecast market forecast, Larry has three questions you should ask yourself:

Is Warren Buffett acting on this expert’s opinion?

If he isn’t, should I be doing so?

What do I know about the value of this forecast that Buffett and the market in general doesn’t?

As Larry told me, “If someone has already told you that they think Buffett’s the greatest investor, it’s hard for them to say that they should do the opposite of what he’s advising them.”

Warren Buffet is a genius. These are good practices, that if done over time consistently will bring great results.

I like the third piece of advice of not timing the market because it seems like every one does that. The idea to make money is to buy low and sell high, but most people buy in only when the market is good, so the purchase at high prices usually, then they sell low because they become afraid of loosing all of their money. So the average person buys high and sells low and never becomes very wealthy

Also big fan of not timing the market. To follow-up on your point about buying low and selling high, another good practice (in addition to the long-term strategy of low-cost indexing) is rebalancing. When an investor rebalances, he or she actually capitalizes on the benefit of buying low and selling high.

Hi, I have to say that I disagree with that, and so would Warren Buffett. To say rebalancing means you plan to sell some stock when the markets are high – this again is just trying to time the markets. Just hold the stock/index. Keep buying into indexes throughout your life, slowly but surely invest into indexes. If there is a sudden crash like in late 2008, then by all means put more than usual into an index.. but a crash is a rare occasion when you can guarantee equities are undervalued. People start selling everything, and confidence becomes ridiculously low, the headlines will all be saying how the markets are screwed.. and equities will often have lost over 30% of their value – to me this seems like the only time when you can “time” the market by putting money into an index – but NEVER sell!!!

Warren doesn’t have to follow his own advice on index funds becuase he has the power to manipulate prices to his advantage. If he was buying stocks/companies at market price he would probably be loosing out to index funds as well. Did you watch what kind of deals he got during the recent crash becuase he was willing to buy/invest when others weren’t? He bought large quantities of stock in several companies (at close to market price), but also go a guarenteed dividend of greater than 10% in some cases.

“Warren Buffett is likely to make at least $1.2 billion from an investment in General Electric struck during the heart of the financial crisis in October 2008.

GE confirmed today it plans to repay Buffett’s $3 billion investment, which helped prop up confidence in the conglomerate as the financial world was being torn apart. Under the terms of the deal, GE owes Buffett a 10% repayment premium, or $300 million, on top of his $3 billion returned investment.

In addition, GE agreed to pay Buffett a 10% annual dividend, or $300 million a year, to rent his seal of approval. That means Buffett will have accumulated $900 million in cumulative dividends, assuming GE repays the preferred-stock investment in October. ”

Becuase of his reputation and purchasing power he can get this. Average investers can not and would be served much better by index funds!

There are only a small percentage of people who have and will have the success of a Warren Buffet, only the smallest fraction of a percent, thus the majority of us will not be able to replicate him.

That being said, the info above has been repeated a MILLION times, even by MR. B along with other info that we hear time and time again.

Most people are successful by working hard, living below their means, learning about investments and they have a little bit of luck or perhaps alot. Oh and there is also a fair amount of quid pro quo and nepotism that goes on.

-What is missing from above is that Buffett like most successful people is an opportunist. He strikes when others do not, of course he was buying the heck out of stuff in 2009 when everyone else was selling. The more experience you have in life the more opportunities you will have seen, many of which you may not have been able to take but it does allow you to be cognizant of the next ones. I have found that dollar cost averaging does not really work, you are better off building assets on opportunities and reallocating to other assets in their down cycles. It is similar to what Buffett does, although he says he doesn’t like to time the market, its not true. He buys assets when they are on sale and holds them until they are overvalued, sure that could be decades depending on what he paid for them and the income they generate. You have to determine if the income generated equates to keeping the asset or whether it should move out for another asset. There is nothing wrong with timing the market, there is a lot semantics because most pros dont’ recommend as most people buy at market highs and sell at bottoms. If you are disciplined you can be successful. Corrections and bears in all asset classes and within classes are cyclical and should viewed as buying opportunites.

What Buffet does isn’t ‘timing’ though. He’s buying on sale with a long view. He doesn’t just scoop up everything that’s cheap; he buys companies that may be suffering a temporary setback or challenge, that he in his experience has confidence they will overcome. It’s that knowledge and experience that most of us lack.

What Buffett does isn’t ‘timing’ though. He’s buying on sale with a long view. He doesn’t just scoop up everything that’s cheap; he buys companies that may be suffering a temporary setback or challenge, that he in his experience has confidence they will overcome. It’s that knowledge and experience that most of us lack.

Great advice. It always cracks me up when people point to Warren Buffet as an example of active investing that works, as if they can replicate it. I mean, when I look at Lebron James, my immediate thought is certainly not “Hey! I could do that too!”

Active managers lose to index funds time and time again. And individual investors trying to pick active funds actually do even worse. Patient, consistent index fund investing is a sure way to above-average performance.

Um…if you only do index investing you will by definition never beat the averages, simply because the index fund will mirror the performance of the index minus the costs…you will always perform worse than the index mathematically.

Financial gurus are successful because, like all media including this blog, they confirm some people’s beliefs. In essence, they confirm how smart those who share their beliefs are. Its not really surprising those same people don’t blame the guru when their mutual belief turns out to be wrong.

Successful money managers don’t manage money, they manage people. They are in sales. You can see this when they start talking about “risk tolerance” as a psychological problem. How much risk are you “comfortable” with. Real “risk tolerance” is determined by your objective investment goals, not by some personality trait.

There are any number of personality traits that may interfere with good investment decisions. Your personal tolerance for risk is only one of them.

Just because you are willing to risk your life climbing mountains doesn’t mean you should make risky investments. It means you should recognize your tendency for risky behavior and try to restrain it in your investment choices. The same is true if you are uncomfortable with risk. You should recognize your need for safety and restrain it in your investment choices. The exact opposite of the advice from most “investment professionals”.

The real advice from Warren Buffet is to make decisions based on reason, not emotion. But that is almost certainly not advice that works to the advantage of any “financial professional”. It argues for putting money in low cost index funds and not paying an investment adviser/sales person.

This is great, I love all three of the points. I know many people may disagree with a few of the points, but how can you disagree with the success Warren has had with investing. I know that I’m definitely not as financially savvy as Warren, so I’ll listen to what he has to say.

I’m very much with Buffet. I ignore the talking heads and I don’t try to time the market.

I don’t invest with index funds, instead I purchase individual securities. But again, I follow Buffet, I try to find great companies trading at low valuations and buy them. Buying individual stocks takes some amount of time and effort. If this isn’t for you, then index funds make the most sense.

Buffett certainly is a genius. I love watching people who think they can do the same as him yet lack the patience to stick with it. One of the many things that sets him apart is that he does not let the fear dictate him. He sticks with his plan for years and decades (just like you said). It may not be as “sexy”, but slow and steady wins the race.

During a recession, the Warren Buffetts of the world look at the economic downturn as “stocks are on sale”. Now that things have rebounded, the harvest of the seeds are bountiful in either increased stock price or hefty dividends.

We don’t need to succeed at the level Warren Buffett does. The standard is simply: can I do well enough for me?

Mr. Buffett became successful when he was small and unknown. And he became successful by spending the time looking at individual businesses which happened to be trading on the stock market.

Anybody putting in that time has a good chance to be successful. His advice to stick with index funds is aimed at folks who don’t have the time or inclination to put in the effort required to succeed with individual stocks…

Warren Buffet is a value investor! He buys companies that are undervalued based on his criteria or he expects it to grow because it is a basic industry. He stays away from any of the sexy tech companies or any other companies he does not understand. An index fund sticks with that philosophy.

Berkshire Hathaway also has the power to influence policy with the companies they invest in, so after identifying an undervalued stock, they can buy up a big chunk of the company and then make sure whatever stupid thing management did to lose investor confidence doesn’t end up eroding the real value of the company.

ETFs generally outperform value investing for individuals without this power.

Well, one problem is that Buffett is in his eighties. For a long-term investor who is significantly younger, the question is: Can anyone else replicate his success once he (and Charles Munger) is no longer running the company? Idex funds, at least those that invest in broad market indexes (like the S&P 500) work more of less the same no matter whose name is on the fund`s stationary, with fees being the primary element to compare.

Great post, Robert. I love Buffett’s investment ideas and writings. I commend his personal frugality, and I look up to him. That being said, he is a self-righteous crony capitalist who doesn’t understand simple economics.

Definitely study Buffett: his ideas make the most sense, and are probably easiest for common folk to follow. But, I think we all need to figure out our own way of investing. Buffett often, somewhat arrogantly, voices his disdain for anything other than value investing. However, if you can make money in the market, who cares how you do it!

OMG, thank you for saying exactly this! One million thumbs up! He has made his empire off of turning paper. Bad paper into good paper. I can’t tolerate the Jesus complex with this guy. He is shrewd and knows exactly what he’s doing with plenty of unethical dealings and inside info. If you want to know where the economy is going, study his example–don’t take for word his advice. I can only assume his latest predictions are of unimaginable inflation (to us 60′s-70′s kids) and to invest the opposite. Regardless, he’s not uncle Buffett. He knows things. Because they let him. But, on the side, yeah–I think he’s a great guy and means well. In business…hell no!

Great recap! Buffett, from what I’ve read about him, also never dwells on past mistakes and understands the significance of independent events; that is, he won’t hesitate to take a risk if his last didn’t pan out.

Yes, I agree to what you have said at the beginning of this article. Not only articles but also Tweets, Facebook posts and a couple of books that have Warren Buffett’s name on it have become the bestseller books that have got the attention of many readers.

I agree with Lucas. Buffet is now at a place in the investment world where his buys are self fulfilling. If he can make 5-10% per trade on every trade his is a genius. His picks will move on the news alone that he is in, therefore he does it effortlessly. No science there.

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